Download Why Project Finance

Agenda
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Introduction to Excel and Financial Modeling
Key Concepts of Excel Modeling and Excel Usage
Understanding financial statements
Understanding Project Finance
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Definition and Relevant industries
Key Characteristics of Project Finance
Public Private Partnership
Risk and Mitigation
• Key Concepts in a RE Model
• Modeling for Commercial Property
• Homework assignment
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Definition of Project Finance
A typical definition
“The financing of the development or exploitation of a right, natural
resource or other asset where the bulk of the financing is to be provided
by way of debt and is to be repaid principally out of the assets being
financed and their revenues”
• The following things need attention
– There is special purpose company (SPV) – a single purpose company
– whose principal assets and business are constituted by that project
– Repayment of loan is essentially limited to the assets of the project being financed
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Origins of Project Finance
• Is this some new concept??
– The modern concept of Project Finance finds its usage more from 1980’s
– The earliest evidence of project finance is found during Roman period
• Uncertain sea voyages in Mediterranean ocean
• To save from nautical perils traders took Fenus Nauticum (sea loan) with local
lenders
• Lenders would get the money back from the proceeds of sale of goods only; in
case of ship not returning ……. Lenders were not paid
• Lenders would send their men with traders to ensure fair play….. (a kind of
trustee)
– Origin of modern project finance – 1970s in Oil and gas sector in UK
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Key industries that find themselves amidst the trend of Project finance
and/ or Public Private Partnerships
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Real Estate
Oil and gas
Petrochemicals
Electricity
Mining and natural resources
Urban and rural infrastructure – Ports, Roads
Rail
Aviation and shipping
Telecommunications
Healthcare
Waste management
The list is endless and opportunities are immense
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Characteristics of Project Finance
• Project Finance is the financing of
– often long-term and large projects
– Increasingly those which provide public services or infrastructure
– Based upon complex financial and contractual structures commonly involving many legal
entities
• Project Finance debt is often termed as "non-recourse" or “limited –recourse”
– Typically secured by the project assets and the core project contracts
• The cash flows from the project
– Come only after the project is fully complete (takes more than a single financial year for
completion)
– are usually the sole means of repayment of the borrowed funds
• Separate Entity and SPV Status
– Risk of the transaction is generally measured by the creditworthiness of the project itself
rather than that of its owners (Sponsors).
• Two main types of Project Financing
– Greenfield – a fresh start
– Brownfield – expansion of an existing project
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Key difference between Project Finance and Corporate Finance
• One of the key differences, lies in the recourse that the lender has to the
assets of the borrower.
• In project financing this recourse is limited to an identifiable pool of
assets, whereas in corporate financing the lender will have recourse to
all the assets of the borrower
• In Corporate finance, liquidation of the borrower is possible on a pari
passu basis where as In the context of a project financing lender would
only be entitled to this ultimate sanction if the project vehicle is an SPV.
• For SPV with multiple activities, ring fence the assets associated with
these activities
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Why Project Finance – is it worth it?
• Project finance is invariably more expensive than raising corporate funding
• It takes considerably more time to organize and involves a considerable dedication of
management time and expertise in implementing, monitoring and administering the
loan during the life of the project
Reasons for opting for project finance
• To insulate sponsors from project failure and debt
• Borrowing restrictions on corporate
• Off balance sheet financing
• Risk sharing in large projects – when balance sheet is not strong enough
• Tax holidays and concessions in some jurisdictions
• Nowadays its becoming a legislative necessity
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Public Private Partnership
• Providing infrastructure has been historically the prerogative and duty of Govts.
• Off-late due to various operational inefficiencies and financial crunch Govts across the world have invited
private sector players to develop key infrastructure
Level of Private Sector Involvement
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PPP Models
Asset
Ownership
Capital
Investment
O&M
Commercial
Risk
Service Contract
Public
Public
Both
Public
Management Contract
Public
Public
Public
Public
Lease
Public
Shared
Private
Shared
Concession
Public
Private
Private
Private
BOT / BOOT
Both
Private
Private
Private
BOO
Private
Private
Private
Private
Divestiture
Private
Private
Private
Private
TYPE
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Typical project life cycle
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Identification of opportunity
Identifying suitable PPP model
Development of project documents (RFP, Concession agreements, share purchase agreement etc)
Formation of SPV
Taking initial project clearances on behalf of SPV
Bidding process
Transferring SPV to successful bidder
Arranging debt by the SPV (Financial closure)
Construction
Operations after COD
Transfer of assets back to the govt after completion of concession period
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Characteristics of Project Finance under PPP mode
• Multiple parties involved
– Sponsors
– Contractors
– Suppliers
– Governments
– Global financiers,
• From inception of an idea to Financial Close, a Project Finance deal can take years to negotiate
• All about identifying risks, allocating them appropriately and ensuring that the responsible
parties are adequately incentivized to manage their risks efficiently
– Construction time, costs & specification
– Operational cost, reliability
– Supply reliability, quality, cost
– Off-take volume, price
– Politicial environment, war, local hostility, currency inconvertibility
– Socio-environmental responsibilities
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Key Stakeholders and SPV structure
SPONSORS
INSURERS
HOST
GOVERNMENT
LENDERS
SPV
EXPERTS
PROFESSIONAL
S
GUARANTORS
PURCHASE
R
EPC
CONTRACTOR
OPERATO
R
SUPPLIER
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Risks & Mitigants
• Ground rules
– Risk allocation – according to
capacity and control
– Never park risk to the
company if it is an SPV
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Risks & Mitigants
• Funding Risk
– Identification of sources for equity contribution.
– Stipulation for minimum upfront equity contribution.
– Disbursement only after financial tie-up for the project.
• Regulatory Risk
– All major statutory approvals including MoEF and forest clearance stipulated as a pre - disbursement
condition
– Concession agreement is reviewed commercially and risks identified
– Suitable undertakings/guarantees are obtained from sponsors to negate any adverse affect of concession
provisions
– Financing of projects on time-tested concession formats approved by the Planning Commission
• Land Acquisition Risk
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Minimum land acquisition stipulated as a pre-disbursement clause
Projects in sensitive states avoided
Land acquisition is the responsibility of Concession Authority
Compensation is paid by the authority on account of any adverse delay
• Market Risk
– Independent consultant appointed by Lenders to conduct market potential/ traffic study
– Project funding is structured based on cashflow projections to ensure smooth Debt servicing
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Risks & Mitigants
• Execution Risk
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Contracts for Civil works/Procurement of equipment on a fixed time fixed price basis.
Contracts to be finalized before any disbursement
Reputation of EPC contractor considered
Suitable provisions for Liquidated damages/ penalty are incorporated in contract documents.
• Technology Risk
– Projects based on proven technology are financed
– Recourse stipulated in case of emerging technologies
• Explicit Political Risks
– Most concession agreements / licenses have clear provisions classifying political risks into 2 categories:
• Direct Political and Indirect Political
• Mitigation mechanisms including compensation is specified in the agreement itself
• Implicit Political Risk
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Policy Risk: Change in policies towards infrastructure like tax sops, concession agreements, grant policies
Revenue/Toll Rate Risk: Change in toll rates
Regime Change Risk
Change in Applicable Laws / Tax Laws
Cross Border Governing Law Enforcement Risk
Concession Agreements / Licenses govern all aspects of projects under a contract based system and
governments honor signed contracts
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Contractual Arrangements to Mitigate Risk
Parties
Agreements
Mitigation mechanisms
Project Sponsors:
Shareholders Agreement/Share
Subscription Agreement, Sponsor
Support Undertakings, Corporate
Guarantees.
They bear the risks of project design, construction, completion,
operation, and maintenance and repayment to the lenders. The
cost overrun risk is also borne by the sponsors.
Customers
Off-take Agreements
When there are only a few potential customers for the project’s
output, revenue risk is likely to be transferred to those customers
by means of a long-term sales contract.
Contracts may include: take-or-pay clause, minimum throughput
agreement, tolling contract etc. The risk of payments is mitigated
through a proper payment security mechanism.
Government/
Statutory
Authorities
Concession/Implementation
Agreements
Construction
Contractors
EPC Agreement
When a government grants a concession to a project company,
there will be a Concession Agreement that gives the company the
right to build and operate the project facility. Concession
agreement may require the government to construct supporting
facilities such as access roads, contains non-compete condition
etc.
The risk of project construction is mitigated to the construction
contractors by entering into a fixed time fixed price contract with
them and the contract adequately providing for liquidated
damages (penalties) in case of delay in construction.
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